Trading In The Currency Market
The currency market is the largest and most liquid of the capital markets. Approximately 5-trillion dollars’ worth of currency is traded around the globe daily. The currency markets are liquid 24-hours a day, 6-days a week. Currency trading generally begins in Australia on Monday and closes in New York on Friday evening. There are several steps you should take before you begin to trade currencies. You should know about the securities that are traded, when they are liquid, what strategies you could use and risk management.
What is a Currency Pair?
The currency market is made up of currency pairs, where the exchange rate between two currencies shifts constantly around the clock. When you trade a currency pair you are always buying one and selling another. You can trade cash currencies where you take delivery of a currency and lend another, or you can use financial instruments like a contract for difference (CFD). A CFD allows you to track the movements of a currency pair without owning the underlying product. The most liquid time zone for most currency pairs is during European hours. Liquidity picks up during Asian hours and slows down in the latter part of the North American trading hours.
What Moves a Currency Pair?
Changes in the currency markets take place all the time. Prices incorporate all the available news and when new information becomes available, the price shifts to reflect the news. For this reason, it’s important to track current news to determine if it will be market moving. During periods where there is no new information, prices will experience noise and will be driven by technical factors. This includes support and resistance, patterns, as well as momentum. Over the long term, currencies are driven by interest rates. The interest rate differential between the 2-currencies drives currency movements. This is because it derives the costs of either lending or borrowing a currency.
There are strategies you should evaluate before you make a currency trade. You need to determine if you want to base your trading ideas off of new information or technical factors. Some use a combination of both. If you are planning on following news, you should also follow economic releases using a financial calendar. You can find a robust calendar on iFOREX.
You also want to determine market sentiment. You can do this by evaluating the markets using technical analysis. Tools like the relative strength index can help you determine if a currency pair is overbought where sentiment it too high or oversold where sentiment is too low.
Lastly, before you risk any capital, you want to make sure you have a strong risk management plan in place. Risk management determines how much you will risk on a trade as well as a strategy. Each trade should have a pre-identified stop loss and take profit. You should also only risk money that you can afford to lose.